Credit cards: defaults force issuers to beat a retreat.

Overview: For those bad credit risks looking for cash, there's always the subprime credit card sector. Once a niche dominated by Providian Financial and a handful of small-town banks, subprime credit became the fastest-growing segment of the $635 billion credit card business during the late 1990s, luring mainstream finance giants such as Capital One.

One reason these firms got into subprime was the increased cost of competing for more attractive customers, many of which already have multiple credit cards in their wallet. Another reason: The higher interest rates and late fees these firms can charge customers, and the ability to package and securitize credit card receivables.

Over the past three years, subprime credit card issuers have been slammed by defaults arising from layoffs and bankruptcies among its base of customers. The result: Once-committed lenders such as Providian, Metris Cos., catalog retailer Spiegel and pioneering Internet bank Nextcard Inc. have either sealed back their subprime business or collapsed altogether.

Stricter scrutiny from banking regulators and hand-wringing by investors have forced Capital One and others to hastily exit the business and sell off their subprime portfolios. In January, federal agencies including the Comptroller of the Currency set new credit restrictions and limited so-called overcharge fees. Three months later, South Dakota-based Bank-first Corp., was forced by the Federal Reserve to halt its subprime operations after revealing that 13 percent of its assets--mostly subprime credit card receivables--were at least 30 days delinquent.

Remaining subprime lenders are monitoring their risks, as defaults remain over the 5 percent overall industry average.

Lenders: One of the largest remaining players is British banking giant HSBC Holdings Plc, which got into the business as part of its acquisition of consumer lender Household International. Then there are specialists like Atlanta-based CompuCredit and Plainview, N.Y.-based Cardworks Inc., which have spent millions of dollars acquiring the remaining portfolios of Spiegel and Mctris. Like mainstream firms, they issue their cards with the imprimatur of Visa International or MasterCard, the main membership organizations (mid transaction processors) for the credit card industry.

Borrowers: The pool of customers for high-interest cards runs the gamut: students, the newly divorced, filmmakers desperate for quick financing of their movie. They also include "slow-payers"--borrowers who have rung up spotty credit histories because they haven't always repaid immediately when their bills came due. The least attractive group? Folks with a history of wage garnishment or bankruptcy.

Rates: Hefty interest rates of 9 percent help the lenders generate cash and reduce the risk associated with a higher default rate. For borrowers whose balances go over the limit, fees of as much as $29 per $500 of borrowing can be charged. For the riskiest credits, issuers offer a "secured card," in which a borrower puts up a deposit to secure a credit line starting as low as $300. That line rises as the credit card holder improves his or her credit history.

Richard Pittman, director of counseling and housing at the Consumer Credit Counseling Service of Los Angeles, remembers one offer for a card with a $250 limit. But after the origination fees and other fees were thrown in, there was a $190 balance on the card to start out with.

"Consumers should be reading the fine print, but they don't," he said. "They fall victim because they have victim mentalities."

Voices

Peter Lucas

Analyst

Card Source One

"The firms still in the market have had to improve their risk modeling. You can predict whether a customer is overextending the credit or whether they'll pay you first or second.

"People are getting savvier. They know that a credit card lender can't take your house away. You have people shifting their balances from one card to another, so you have to look out for that. Or you have a case like someone I know who went through a divorce and found out afterwards that his ex-wife was charging up the cards because she still had her name on them.

"It's tough for all the credit card lenders, but subprimers have it worse because they deal with people who may not have the propensity to pay their bills."

James Daly 

Editor

Credit Card Management

"I remember a decade and a half ago when subprime credit cards were issued by these no-name banks like (now-defunct) Bank of Hoven.

"Then you began seeing lenders who had only dealt with better credit pools such as a Citibank getting in there. But then they got bit because they extended themselves too far into the credit pools. Some of them saw their portfolios blow up and the regulators clamped down on them.

"Now we're back to the small, specialized low-profile banks. The lesson: if managed well, sub-prime can do well. But it can blow up in your face."

Richard Pittman

Director of Counseling and Housing

Consumer Credit Counseling Service of

Los Angeles

"Some of these guys are real aggressive. They have these low come-on rates. But the steps are in the fine print. It's truly risk-based pricing you're getting. If you pay on time, you don't stumble, you don't get laid off, then you get the low rate. But if you miss a payment, you may end up paying 13.9 percent for nine to 12 months.

"(Victims) think about paying the bills and paying the rent. They don't think about the cost."